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An effort is made to gather customer investment profile information which includes their financial situation, other securities/assets, investment objects, and tax details.

Goals and objectives of the investor

The client’s goals and objectives are something that must be discussed as well.

Investment goals

You can start with their investment goals.

Remember, the goal is the endpoint and objectives are the points along the way that need to be met to reach that endpoint.

The most common goals are:

  • Planning for children’s college education
  • Planning for retirement
  • Saving towards a large purchase, in most cases, a home
  • Wanting to give money to charity
  • The need to raise capital to begin a business

Investment objectives – Section 1

Now that we’ve covered some of the more common goals that investors have, let’s talk about the three main investment objectives that help ensure that these goals are reached.

These are:

  • Growth (for example, conservative, moderate, and aggressive)
  • Income (for example, high-risk, current, or future)
  • Stability (the preservation of capital)

It’s never that simple, however.

That’s because there are usually obstacles in the way that make the path to reaching these investment objectives a little more difficult.

These are known as investment constraints and we will look at them in greater detail later in this guide.

Note, that speculation describes an object that looks for either maximum income or growth but forfeits stability.

Investment objectives vs investment constraints

In this section, we cover the investment constraints that can threaten investment objectives.

Investment Objectives – Section 2

We’ve discussed the importance of investment objectives already and how they are the stepping stones to investment goals.

We also mentioned that it’s investment constraints that can be potential obstacles.

Note, that investment constraints are always client-specific.

While we’ve covered investment objectives briefly, it’s necessary to look at them in far greater detail.

Preservation of capital.

For many investors, a drop in the value of their investments is something they don’t want to see.

That’s why turning to more stable investments, like bank-insured CDs, is an option.

But risk reduction means less income.

They are also exposed to inflation risk too.

Income

Some investors are all about income as their goal.

Linked to that is the amount of risk they take.

It’s the old principle of risk vs reward and the more an investor does risk, the higher that reward could potentially be and vice versa, of course.

Perhaps investing in U.S. Treasury stock is the way to go for an investor that’s looking for income with some safety too.

For those where nothing else but income matters, high-yield (junk) bonds offer an outlet for investment.

Capital appreciation or growth

A broad range of objectives can cover the term growth.

Ultimately, it’s up to the registered representative to find a happy medium for their client and their investment as far as growth is concerned.

Some might choose securities that offer more conservative growth but relatively safety and others might want a riskier option that provides huge growth potential.

Speculation

This can be listed as an objective too, although it’s usually found as a sub-category of growth.

This describes a situation where a client is prepared to accept risks that are above average to see returns that are above average too.

To do that, they often trade in options or penny stocks, use margins or sell short.

Registered representatives will have to deal with these situations and determine if that which the investor wants to trade in fits in with their overall suitability.

Investment constraints

Let’s now move on to investment constraints and what they entail.

There are five main constraints that a registered representative will have to consider for each of their clients.

  • Time horizon: This describes the period of time in which the goals must be achieved.
  • Liquidity: This is determined by the cash needed. For example, if goals are immediate for example, retirement, liquidity is high. If goals are further away, liquidity is far lower.
  • Taxes: This describes an investor’s tax characteristics as well as how much tax management needs to be focused on.
  • Laws and regulations: Are there any laws and regulations that prevent an investor from purchasing certain types of investments, or is the client an accredited investor?
  • Unique circumstances or client preferences: Each client will have unique circumstances or preferences that could be an investment constraint. For example, they might want to avoid investing in a particular security that would benefit them.

Time horizon

This is a critical factor that will help a client and registered representative decide on the level of volatility their investments should take on.

If the time horizon spans a couple of decades, then it’s acceptable to look for securities that offer short-term volatility.

Should the money be needed in the next couple of years, then the investment should focus on liquidity and the overall safety of the investments.

For those planning to invest for their children’s education or towards their retirement, this is a very important constraint to deal with.

Liquidity

This is a constraint for investors who want to make a certain amount of money.

It could be for their child’s tuition or they want to purchase a home.

Perhaps they just want an investment where the money is readily available should they need it.

In a case like this, the kind of assets they need in their portfolio are those that offer liquidity.

Those products are determined by a few factors:

  • They can be sold quickly
  • They can be sold for at on or close to their face value
  • If they cannot be sold at face value, they still can achieve a fair market price

Liquid investments are foolproof and certainly don’t mean an investor cannot make a loss on them.

All a liquid investment offers is a fair market price should you wish to sell them quickly.

Here are some examples of liquid investments:

  • Nasdaq or exchange-listed securities
  • Mutual and exchange-traded funds
  • REITs

These investments are examples of illiquid investments:

  • Annuities for investors under the age of 59.5
  • Real estate
  • Private placement purchased securities
  • Hedge funds
  • DDPs

Taxes

This plays a huge role when deciding on the suitability of certain securities for clients.

Taxes can be reduced in two ways.

First, by tax deferral.

Certain investments like IRAs or qualified retirement plans are tax-deductible.

Tax is only paid on them when the funds are withdrawn, for example, at retirement.

The two main benefits of this are that it’s pre-tax money that’s put into these investments and secondly, income and growth on the investment are not taxed either.

The second way to reduce tax is through a tax-free income.

Using an investment vehicle like municipal bonds, this is possible.

That’s because the income they generate is free from federal taxation although in some cases they are taxed at the state level.

Because interest is tax-free, however, these bonds are different from taxable bonds because generally, they pay at a lower rate.

It’s not only municipal bonds through which tax-free earnings can be generated.

Coverdell ESAs and Roth IRAS can do it too as well as Section 529 plans.

Laws and regulations

All you need to do to see how these can affect investment is think of an accredited investor.

Based on what they’ve learned about a client, a registered representative might come across a stock that’s perfect for them but because they aren’t an accredited investor, the purchase of that stock is not possible.

Or, that perfect stock cannot be bought in the state the client lives in because it’s not registered there.

As you can see, laws and regulations can pose a pretty significant constraint to investment.

The last investment constraint we are going to look at is a client’s unique circumstances or any particular investment preference they might have.

While many of the goals that investors have are pretty common across the board, they are still individuals with unique circumstances.

From time to time, those unique circumstances will affect investment decisions.

An example of this is someone who won’t invest in companies that don’t have solid environmental policies.

Many people practice Environmental, Social, and Governance (ESG) investing.

Another example of a unique investor is one who has won millions in the lottery.

A change in their circumstances will result in a change in their investments.

So with all of these constraints, it’s important to find those which will impact each client and consider them against their goals and objectives to properly formulate an investment plan for them.

Suitability according to FINRA rule 2111

When it comes to suitability rules, FINRA always wants broker-dealers to treat customers fairly.

That comes by ensuring that the investment strategy or transaction they have suggested would be suitable for them.

As we’ve mentioned already, understanding customer suitability is all about getting the right information about them.

Customers will make better-informed investment decisions if they understand each investment’s risk and rewards.

FINRA, in 2011, made a huge change to its suitability rules with the introduction of Rule 2111.

This brings three major obligations to the party.

These are:

  • Reasonable-basis suitability
  • Customer-specific suitability
  • Quantitative suitability

Reasonable-basis stability

Here, a reasonable basis must be reached that the investment recommendation from a registered representative is going to suit some investors.

That’s helped by looking at the recommended security or investment strategy and seeing not only the potential reward but the risks as well.

The suitability rule is violated by those registered representatives that can’t or won’t explain the potential risks when suggesting a particular security or strategy.

Customer-specific suitability

Suitability also needs to be taken into account for specific customers and that’s what customer-specific suitability covers.

Those suitability recommendations for specific securities or investments are made easier by looking closely at each customer’s investment profile.

For example, an older customer might show a more diminished capacity for investing as they get older.

That’s going to change the kinds of investment products suggested to them from those they’ve used before when they were a sophisticated investor.

Quantitative suitability

This comes into play when the registered representative has been given control of a customer’s account.

Here, they have to take into account the transactions carried out, and whether they have a reasonable basis for believing that together, they are not unsuitable or excessive.

The thing is, when looked at in isolation, these transactions might seem to make sense but looking at them as a collective is necessary too, especially with excessive activity in mind.

To do that, the following can be taken into account to see if the quantitative suitability obligation has been violated:

  • Commissions generated from the transactions
  • The profit to cost ratio of the transactions
  • The use of in-and-out trading
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